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Can I Still Deduct My Mortgage Interest?

Can I Still Deduct My Mortgage Interest? This has to be one of the most frequent questions I have received after the Tax Cuts and Jobs Act became law.  These new rules will impact primary and second home purchases in 2018 and will revert back to the old rules after 2025.  You will need to understand the new rules if you are refinancing your current home, thinking about drawing on home equity line, or taking out a new home equity loan.  I will try to give you the basics here.

mortgage interest

The Old Rules

Under the old rules taxpayers may claim an itemized deduction for “qualified residence interest”.  This is interest that is paid during the year on up to $1,000,000 ($500,000 for married individuals filing separately) acquisition indebtedness that’s secured by a qualified residence.  Acquisition indebtedness being defined as debt secured by the taxpayer’s principal home and/or second home incurred to acquire, construct or substantial improve the home.  Acquisition debt also includes debt used to refinance acquisition indebtedness to the extent of the refinanced debt being paid off.

Also, under the old rules, taxpayers could deduct interest on home equity debt incurred up to $100,000 ($50,000 for married individuals filing separately) secured by a qualified residence used for any purpose other than for acquiring, constructing or substantially improving the taxpayer’s qualified residence.  The home equity indebtedness could also not exceed the fair market value of the residence after reducing it by the qualified acquisition indebtedness (your equity).

New Rules

Under the new law the deduction for home equity interest is no longer deductible for tax years 2018 through 2025 if the amount borrowed was used for any purpose other than to acquire, construct or substantially improve the taxpayer’s qualified residence.  This rule applies regardless when the home equity debt was incurred.  It does not matter what the lender calls the loan.  A home equity loan used to acquire, construct or substantial improve a qualified residence will remain deductible as long as it does not exceed the indebtedness limit when added to other indebtedness.

Under the new law the maximum acquisition debt has been reduced to $750,000 ($375,000 for marrieds filing separately) for indebtedness incurred after December 31, 2017.  Debt incurred on or before December 15, 2017 are grandfathered in under the old limit of $1,000,000 acquisition indebtedness.  There is an exception.  If you had a binding contract before December 15, 2017 to close on the purchase of a principal residence and purchase that residence before April 1, 2018 you will be treated as having incurred that indebtedness before December 15, 2017.

In applying the $750,000 acquisition debt limit above to any indebtedness incurred after December 15, 2017, the $750,000 limit must be reduced (but not below zero) by the amount of any indebtedness incurred on or before December 15, 2017 that is treated as acquisition indebtedness for the tax year.  For example, you purchased your primary residence in 2016 and are considering purchasing a second home in 2018 and financing $300,000 of the purchase price.  On January 1, 2018 the balance of your primary loan is $800,000.  Even though the interest on your primary residence remains fully deductible in 2018, none of the interest on the new second home will be deductible as the new indebtedness excessed the acquisition debt limit after subtracting the balance of loan on your primary residence ($750,000 less $800,000).  Your debt limit has been reduced to zero for any new borrowing on a qualified residence.

The $1,000,000 limit under the old rule applies to debt arising from refinancing debt that was originally incurred prior to December 15, 2017 to the extent the debt resulting from the refinancing does not exceed the balance of the debt immediately prior to refinancing.  Thus, you will not be able to take out new money, even for improvements to your home, if the debt prior to refinancing exceeds $750,0000.

If you would like to discuss how these changes affect your particular situation, and any planning moves you should consider in light of them, please give me a call.

About the Author

Jim SnyderJames Snyder, CPA, CSPM is a principal at YHB in the Leesburg, VA office. He provides income and estate planning services, business consulting, and estate and trust administration services to successful individuals in many professions, especially engineering, law, technology and real estate. He also provides strategic guidance and planning for clients involved in stock option transactions and wealth transfer.